Growing Services

As I wrote about last month, Apple continues to evolve into a company that provides (and makes money off of) services. Last quarter, Apple pulled in a total of $84.3 billion. Apple’s services generated $10.9 billion in revenue, up 19% from a year prior. Apple’s services revenue comprised 13% of their total revenue. Although Tim Cook touts Apple as a services company, and many of their most recent moves back that up, they have a long ways to go to diversify their hardware revenue, especially non-iPhone revenue.

Even more importantly, Apple reported its margin in the services category, coming in at 62.8%. Much higher than Apple’s overall margins of 38%. And this is why investors love services – low spend, high profits.

As you can see in the chart below, Apple’s services’ revenue is much more consistent than the cyclical iPhone revenue. As a long term investor, I’m not that concerned about this, but Wall Street loves this consistency.

Google, the App Store, and Lazy Money

Apple’s services’ revenue is growing quickly, it’s consistent, and its margins are thick. The bad news is the bulk of the services’ revenue is coming from lazy money.

WTF is lazy money? Well, in one way it’s good. It’s money you don’t work for. Google, for instance, makes up approximately 20% of Apple’s services revenue by paying Apple for placement in the Safari toolbar. This is great although does come at a cost to the user. Apple could, as they normally do, remain laser-focused on the user experience and choose the search engine that offers users the best UX. With Apple’s privacy focus, DuckDuckGo appears to be an obvious choice for Apple. Instead, Apple gives this real estate to the highest bidder, the not-so-privacy focused Google. I’ll get back to the privacy issue later.

Apple also makes lazy money through the app store. Apple charges 30% to app developers for the sale of an app and/or the first year of a subscription. Apple takes 15% annually from app subscription revenue after that. Some of this revenue is earned. Apple sets guidelines and vets app to protect their users. The App Store also allows users to search and discover apps easily and quickly. But some of this is rent-seeking, such as attempting to take 15% of ongoing revenue from Netflix subscriptions. Netflix has decided they will no longer allow users to subscribe through the app. Again, Apple is arguably sacrificing the UX in order to make lazy money.

SaaS Money

Apple Music and iCloud are more textbook services. With these services, users are signing up for monthly subscriptions that they pay for. These services are sticky. Once a user creates their playlists in Apple Music or gets all of their images/files into iCloud, they become entrenched. But, this isn’t easy money for Apple. Apple will have to continue to maintain and improve these services in order to keep their users.

News, TV, Gaming and More!

The Apple services rumor mill is hot. The Apple News service appears to be coming soon. A TV/Movie service after that and potentially a gaming service down the road.

Apple is leveraging its distribution advantage of the iPhone, iPad, and (to a much lesser extent) AppleTV to launch services. As mentioned last month, this is a sound, but risk-averse strategy.

Apple Privacy

Tim Cook has been harsh on the other tech giants when it comes to privacy. Taking many opportunities to bash Facebook, Google, and others that use the information they have about their user to serve targeted ads. Furthermore, and perhaps their most overstepping behavior, Apple has insisted that every app in the app store disclose when they are recording a user’s behavior.

Although I commend Apple’s respect for user privacy, this is an example of why it’s hard for companies to change what they do. Apple has made money selling computers in many different form factors, but creating a best-in-class service is much different. Good product managers of a service let’s data be their guidance. Every major website we interact with is tracking how their users use it, and this data is used to improve the UX. SaaS 101. Apple’s attempt to take a moral high road will result in inferior services. So far, unlike Apple devices, Apple has yet to make a service that is best in class. Apple Music, Apple Maps, etc may someday have more users than Spotify or Google Maps on iOS devices but that will mostly be because of the value of default apps, not because of a superior service.

Bottom Line

I’m open-minded. We’ll see if I have to eat crow on my assertion that Apple is incapable of making a best-in-class service without sacrificing some privacy. I suspect Apple will eventually start to track behavior to improve the UX and collect information to enhance personalization.

Either way, Apple will make money from these services and the services’ revenue will continue to make up a larger slice of their revenue pie.

Good Enough for Warren

Apple is a hell of a company. So much so, the greatest investor of all time, Warren Buffett, has nearly $40B worth of Apple stock through Berkshire Hathaway.

Apple has become the perfect Berkshire Hathaway investment. It has a solid brand that has lasted the test of time. It’s a profit machine, the most in the history of a public company. It’s sitting on a giant pile of cash ($130B) and it’s putting that cash to use the way Warren likes. Apple provides a healthy dividend, currently a 1.85% yield, and consistently buys shares back. Finally, Apple is giant, which means Warren can park a lot of cash in it.

That’s the good news, the bad news is Warren likes to invest in boring, risk-averse companies.

There are other signs that Apple isn’t pushing the envelope. Tim Cook has been beating the “Services” drum, indicating Apple is morphing into more of a services company. This is a nice safe bet for Apple. Leverage the massive success with devices as a way to push services and make easy money. Apple Music, which is a giant success, is exhibit A. Furthermore, Services are cheaper for Apple to create, easier to go to market, and less risky than hardware. If Apple has a flop with hardware, the critics will have a field day.

Apple seems hooked on “rent-seeking” activity. Taking an annual cut of Netflix subscriptions bought through the App Store, for example. This is the type of activity I expect from a more desperate company, not one that is focused on the long-term.

Watch and AirPods are huge successes. Each capitalized on Apple’s strengths, integration of hardware & software, and leveraged the success of the iPhone. Both were safe bets with relatively little friction.

Compare this to their original giant successes, the iPod and the iPhone. Those products also capitalized on Apple’s strength of integrating hardware & software but they were huge risks. They both required Apple to change the industries they entered. With the iPod, Apple was able to convince music labels to sell music via iTunes. With the iPhone, Apple convinced the carriers (only AT&T at first) to leave their bloatware off and to give Apple complete control of the user experience. These products had major friction to overcome, both were big risks, and both become massive successes.

R&D Spending

The good news is, as revenue has grown, so has Apple’s R&D spending, but they trail the Googles and Amazons of the world in this (with the percent of revenue)

“Speaking before this week’s results, he said Bernstein estimated that Apple spent 5.1 percent of its revenue on R&D which is less than its rivals. “Apple could double its R&D and be relatively inline with peers”.”

Amazon and Google

It’s not just the spending that makes me think Apple isn’t taking as many risks as their peers. Google has their “moonshots” and Amazon enters every business imaginable. Buying Whole Foods is an example of Amazon taking a large risk.

As much as I want Apple to take a larger risk, I don’t think they should follow Google or Amazon’s playbook. My beef with the risks that these companies take is many of them are not leveraging their core competencies. Google’s moonshots have so far fallen flat and have not born fruit, despite the heavy investment.

Amazon has surprisingly been successful in areas outside their core competency (i.e. Alexa) but have had flops in areas they had no business being in (i.e. Fire Phone)

Bigger Risks

So what type of risks would I like Apple to take? Apple should aim to develop a product with the following characteristics –

Requires the integration of software and hardware

Requires a significant change to an established industry

Requires a long R&D cycle to pull off

Is within a product category where Apple can make THE premium product

Has major profit potential ($5B+ / quarter)

Televisions, the only major screen people use that Apple doesn’t have a product in, is the first obvious choice, as many have written about before. Television is in the middle of a transformation, with cable subscribers shrinking (although slowly) and streaming services growing. Although streaming is growing their overall offerings fall far short of traditional cable.

Automobiles are the second obvious choice. Cars are becoming more and more reliant on software as automated driving becomes more mainstream. This may be a perfect time for Apple to pounce. Manufacturing a car, at scale, is no joke, as Elon Musk can tell you. This move would be orders of magnitude riskier than a TV but with higher profit potential.

Bottom Line

Apple is secretive with their R&D efforts. There is a good chance Apple looks risk-averse on the outside but is indeed working on products that are high-risk.

Apple’s current strategy is rock solid. It’s a little too safe for my taste, but growing services and making more peripherals to the iPhone can easily get Apple well above the height of their previous trillion dollar market cap.

We’re still a long ways away from peak apple, but as a consumer, I hope they swing for the fences.

Not So Peak Apple

When Steve Jobs returned to Apple in 1997, Michael Dell, CEO of Dell, was asked what he’d do if he were in Jobs’ shoes, Dell said:

“What would I do? I’d shut it down and give the money back to the shareholders.”

In 2006, when the Apple smartphone rumors started building steam, Ed Colligan, CEO of Palm had this to say

“We’ve learned and struggled for a few years here figuring out how to make a decent phone,” he said. “PC guys are not going to just figure this out. They’re not going to just walk in.”

In 2007, when Apple was on the verge of releasing the iPhone, Steve Ballmer, CEO of Microsoft had this to say

“Now we’ll get a chance to go through this again in phones and music players. There’s no chance that the iPhone is going to get any significant market share. No chance. It’s a $500 subsidized item. They may make a lot of money. But if you actually take a look at the 1.3 billion phones that get sold, I’d prefer to have our software in 60% or 70% or 80% of them, than I would to have 2% or 3%, which is what Apple might get.”

Beyond those infamous quotes, there has been an onslaught of “Peak Apple” predictions and articles from every corner. Below you can see the Peak Apple articles themselves hit a peak in October 2011, when Steve Jobs passed away.

Google Trends graph for “peak apple”

Fast forward to 2018 and a lot happened. Dell shrunk and had to go private. Palm was acquired and is out of the smartphone game. Microsoft is out of the smartphone game and Ballmer retired. But one thing has remained the same, Apple continues to grow.

How it Got to a Trillion

Apple’s march to a trillion starts off with Steve Jobs’ integrated approach to creating products. Unlike Dell, who focused on the hardware, or Microsoft who focused on the software, Apple focused on both. During the 80s, 90s and early 2000s, this integrated approach to building PCs was great but not as great as a business as Dell’s and Microsoft’s specialziation strategy. Dell and Microsoft made more revenue during this era but Apple was building an expertise – building hardware and software that worked in harmony.

In 1997, Steve Jobs returned to a down-and-out Apple as CEO. Apple had lost its way and Jobs immediately cut down the product lines to establish focus. This focus enabled Apple to be ready for the next big opportunity, the iPod in 2001. The iPod was the first modern device Apple made that leveraged its competitive advantage of building integrated products to take advantage of a macro trend, in this case the rise of MP3s.

The focus, the integrated product approach and specifically the iPod set Apple up to take advantage of perhaps the biggest product opportunity ever – the smartphone. As wireless broadband, ARM processors, lithium batteries and touchscreen technology reached a point of maturity, Apple was ready to pounce and exploit its expertise to fill an enormous demand for smartphones. And pounce they did, creating the iPhone that has been the main revenue driver that allowed Apple to become the first publicly traded $1 trillion company in the US.

What’s Next For Apple?

Is this it for Apple? Is this the peak? I sure as hell won’t make the mistake of attempting that prediction.

The iPhone will continue to be a money maker for Apple for some time. Despite experiencing a plateau with total iPhones shipped, the iPhone continues to grow in revenue by moving more high-end and adding more tiers. Furthermore, Apple has opportunities to ship more units as India and China’s middle class grows, time will tell if we’ve reached peak iPhone shipments. The services revenue and peripherals (Watch, AirPods) will continue to grow revenue for Apple.

But keeping the status quo is not the company Steve Jobs wanted to build and it’s not the company he left behind. Like Walt Disney before him, Jobs established a company of values and conviction that can survive and thrive well after his death. Perhaps the best part about speculating Apple’s future is how tight-lipped they are with future plans. Will Apple ride the VR wave? Will Apple be a player with autonomous cars? We don’t know the answers to that yet but you can bet Apple won’t rest on its laurels. Apple will, for the most part, avoid increasing revenue through acquisitions and will instead invest heavily in creating products that allow Apple’s integrated approach to shine.

Like the Apple Watch and AirpPods before it, many think the HomePod is a flop. There are common criticisms and rationale behind this sentiment. In the end, the HomePod will play out like the Watch and AirPods. It’ll be the most loved and most profitable product in its market.

The “Smart Speaker” category is just getting started. Amazon, with their Echo family of speakers owns 70% of the market. Google owns 25%. But, only 20% of US Adults own a smart speaker. From the iPhone to the Watch this is one of the least mature industries Apple has entered in awhile.

Apple’s foray into Smart Speakers is the same playbook they’ve followed for decades. Apple is never the first mover, they’re always “overpriced” and “under featured”. The HomePod is all of these to the T yet those who follow Apple closely believe this time is different. That Amazon has an insurmountable lead.

The HomePod’s strengths compared to the competition is voice recognition and sound quality. Siri may not be as accurate and robust as Alexa but the HomePod is most likely to hear your command. The price point is much higher than Amazon’s and Google’s products but the sound quality is arguably the best. Smart Speakers largest use case so far is to play music. Apple is making sure they nail this.

Ben Thompson believes HomePod’s sole native integration with Apple Music is an example of Apple’s strategy of squeezing more out of current customers. He cites Apple’s iPod’s interoperability with Windows as a clear difference in Apple’s strategy with HomePod. Ben forgets the first generation iPod was only MacOS compatible. Time well tell if Apple provides better support for Spotify and Amazon Music.

Apple continues to follow Apple’s strategy since its inception – ensure Apple products work best within the Apple ecosystem first and foremost. Airplay from an iPhone, using Siri to play Apple Music – make sure these experiences work 99.9% of the time before rushing to support other systems.

Amazon’s strategy is much different. Amazon is focused on creating cheap devices. They’re on the lower end of sound quality and the price point implies the margins are slim or non-existent. Amazon doesn’t announce their strategy but there are two strategies that make sense when selling something at a loss. The first is to ensure market share and slowly but surely raise the price until you’re profitable. The second is to make money off of the device in other ways. Microsoft famously lost money on every Xbox but made it up on licensing from games sold. Google doesn’t make money off of Android but off of Google Searches on Android phones. Amazon believes those with an Alexa device in their home will buy more stuff from Amazon. Will this be true? So far there is evidence of correlation but not causation.

Beyond price, Amazon’s Alexa is a better voice assistant than Apple’s Siri. But…both leave a lot to be desired. Despite the majority of people having access to voice assistants on their phone, only 46% have used them once. Of those who do use it, only 39% found that voice assistants accurately respond to their commands most of the time. Imagine if Google Search was only 39% accurate? Voice assistants aren’t quite ready for prime time.

Apple is behind on market share. HomePod is expensive. But HomePod is the best at what people use Smart Speakers for – playing music. The price point will drop, the HomePod will support more third party devices/streaming apps and Siri will catch up to Alexa and Google Assistant. Ultimately the HomePod will never have the most market share but they will own the most profit in the category.

Beat reporting, also known as specialized reporting, is a genre of journalism that can be described as the craft of in-depth reporting on a particular issue, sector, organization or institution over time.

This month I’m taking a break from writing about tech to get meta. I want to write about writing.

My favorite content online is by those who have a beat. Writers with specialized knowledge on a subject. Writers with an expertise, not those summarizing a press release.

There are two other commonalities about these writers that separate them from the pack. They have a distinct voice. I enjoy the way their writing sounds when I read it in my head. But perhaps more importantly, they all took a positive beat. M.G. and Gruber are known as being Apple Fanboys. Josh was able to see Facebook’s potential when many doubted them.

But, surprisingly, I find taking a positive beat rare. Even more of a bummer, M.G., Gruber and Josh are all spilling more ink on critical, negative beats. M.G. loves Amazon but hates Facebook and has grown more critical of Apple. Gruber is generally pro-Apple but detests Trump, Facebook, Guns and Google. Josh prefers to criticize Snap, and like the rest of the blogosphere, crucified Facebook over Cambridge Analytica.

After a newsletter where M.G. was bearish on the HomePod and MoviePass I wrote to him:

A lot of negativity in this one! HomePod is a flop, MoviePass won’t work out, etc.

Not that you always have to be a cheerleader but I think writing on things you are bullish about have always been your sweet spots. Back in the day you nailed the positives about Apple when the majority of your peers were pressed to write hit pieces.

I know you know this, but I think time will tell your take on the HomePod is wrong. Apple is playing the same strategy they’ve always played with devices. Go high-end, have good margins to start, don’t worry about market share. Marketshare comes with a superior product. I hope you write this down as claim chowder for yourself, if Apple shows a Watch-esque position with the voice-commanded speaker market, they pulled it off.

He replied:

I try not to think of things as negative vs. positive, I care far more about being proven right in the end! And yes, we’ll see how HomePod does — especially after the first price cut and launch of SiriKit at WWDC!

+1. Being right is more important than being positive. I’d never want to take an incorrect positive stance.

Hating clouds your judgement. People are at their worse (and illogical) when they’re offended and outraged.

M.G. made his mark by making the Apple bears look like fools. While most were writing about “Peak Apple”, M.G. saved their claims as claim chowder. When their foolish predictions were proven incorrect, he call em out. Yet, here is M.G., three years ago, incorrectly claiming (by nearly 500mm users) that we reached Peak Facebook.

Gruber, Siegler and Constine all took bearish stances on Facebook the last couple of months. I decided to go against the grain and defend them. As Facebook’s latest earnings report shows, the media once again overreacted.

And there you have it, my negative take on negative takes. M.G. is right, stick to being correct first and foremost, but there is too much positive going on in this world to focus on the negative. Negative bias appears stronger than Positive bias. Those who hate tend to get it wrong.

As I write going forward, I want to concentrate on the following. Write about what I know. If I don’t have anything good to say, I won’t say it all. I’ll find something else to cover. Put your money where your mouth is. If I write positively about a company, I should own their stock. And finally, write using a voice. This last part, the most important, is also the toughest.

Apple kicked off the September Special Event with a an opening statement from Steve Jobs.

There’s lots of ways to be as a person. And some people express their deep appreciation in different ways. But one of the ways that I believe people express their appreciation to the rest of humanity is to make something wonderful and put it out there. And you never meet the people, you never shake their hands, you never hear their story or tell yours, but somehow, in the act of making something with a great deal of care and love, something is transmitted there. And it’s a way of expressing to the rest of our species our deep appreciation. So we need to be true to who we are, and remember what’s really important to us. That’s what is going to keep Apple Apple, if we keep us us.

The Steve Jobs story is a rich one with many twists and turns. I love the fact that something as grandiose as Apple Park is the last pillar of his gigantic legacy.

The Pros – What I Liked

The most telling part is the lack of criticism coming out of this Special Event. Nothing of the size of furor created over the headjack removal at the last iPhone event anyway. It’s hard to walk away from that event and claim we’ve reached Peak Apple or that Apple can’t innovate.

Watch

Apple Watch is a huge success. In late 2006, Palm’s chief executive Ed Colligan quipped “PC guys are not going to just figure this out. They’re not going to just walk in [and take over the smartphone industry].” Poor Ed was a little off on that one and those who thought Watch was a flop were off as well. Apple is now the largest (by revenue) Watch maker in the world. How crazy is that?

I can’t wait to go for a run with only my watch (and without my phone). This will be a big win for me. It’s a bummer Verizon is going to get another $10 / month out of me but it’s worth it.

iPhone X

As a consumer, I’m excited. It looks like it’s time to for me to size up my phone. RIP 4.7″ diagonal. I hope this bad boy fits in my jeans.

As an investor, I’m amped. The iPhone X will increase the average price without decreasing the amount of iPhones sold (since more price conscious buyers may opt for the iPhone 8).

The Cons – My Concerns

No Surprise

Apple’s ability to keep a secret seems to be slipping these days. This event would have been more impactful if the iPhone X was a complete surprise. Can Apple shore up their supply chain and software releases? Can Apple get back to their secret-keeping ways?

Will FaceID work well?

Demo fails happen and I’m not putting much into the FaceID fail we saw during the event. Would Apple push FaceID out if it wasn’t objectively better than TouchID? Is the edge to edge screen an important enough trade off for an inferior way to unlock your phone? I’m going to trust Apple for now and assume FaceID will be a step forward. This is the most controversial and criticized thing about the Special Event. Like many things (antennaGate, removal of the headphone jack, the iPad name) I expect these concerns will go unfounded.

Expanding Choices

While I’m feeling nostalgic, let’s quote Steve Jobs again

“People think focus means saying yes to the thing you’ve got to focus on. But that’s not what it means at all. It means saying no to the hundred other good ideas that there are. You have to pick carefully. I’m actually as proud of the things we haven’t done as the things I have done. Innovation is saying ‘no’ to 1,000 things.”

When Steve Jobs took over the reins he cut the product line down to two consumer desktops and portables and two pro desktops and portables. Since then the product lines at Apple have slowly grew. What the sweet spot here is debatable and ever changing. I don’t think Apple has went overboard but they are beginning to stretch themselves thin. The bigger problem is the paradox of choice. Having the average consumer decide between eight different iPhones is risky. I’m baffled that they didn’t sunset the iPhone 6 series at the very least.

iPhone X

WTF is up with that notch? Seems like something Jobs would have hated and something I expect Jony Ive to keep on the cutting room floor. I don’t want to jump the gun here and judge before it’s in my hands but this is a compromise, it’s not the ideal design.

I don’t understand the branding choice. I could have got behind iPhone X pronounced “ex” but calling it an iPhone 10 seems odd. What happened to 9? That comes next year?

From a business perspective, where does Apple go from here? Do they continue to offer an iPhone X-esque device going forward? If not, I expect a short-term surge in revenue this year from iPhone 7 users upgrading early to get their hands on the iPhone X but that comes at the expense of revenue next year. For buy-and-hold types, this isn’t an issue, but it may cause the stock to perform like it did after the iPhone 6 and 6s launch (and the year after).

Bottom Line

My Apple spending budget is bursting at its seams. I’m going to buy the new Apple Watch, the iPhone X and the Homepod. But what can I do? Apple continues to bring the goods.

This isn’t 2007 or 2010 when the iPhone and iPad debuted but the Spectacles and AirPods have had a lot of hype. I had my doubts. I never liked Earpods, they’re uncomfortable and fall out of my ear. I didn’t immediately dig the style of the Spectacles. Despite those concerns, I had to buy both and try them for myself.

What Spectacles Do

Spectacles take up to 3 consecutive 10 second 720p videos. Click the button once to take a 10 second clip. Click again when the video is about to end to extend it twice, up to 30 seconds. Pairing Spectacles are a breeze – use the Spectacles to take a video of your Snapcode to pair. When not paired, Spectacles take snaps and sync later once paired.

Spectacles excel with physical activities. Riding a bike and beach volleyball are great examples. Times where a first-person point of view is compelling. Any two handed activity, like pouring a beer or driving a car, make great Spectacle snaps.

What AirPods Do

Like the Spectacles, pairing with AirPods is amazing. Take them out of the case near your phone and they immediately detect and pair. Going from phone to computer is seamless. The sound, microphone and fit are outstanding. I forget they are in my ear. They’ve lived up to the hype.

Cases

Both Spectacles and AirPods come with high quality cases that charge the devices. The Spectacles case is bulky and I find charging without easier. The AirPods case is excellent. Bye bye Wires! Carrying a small case is a subtle improvement that affects me every day.

Simplicity

Spectacles and AirPods are simple and limited. Unlike Google Glass before it, Spectacles do one thing and only one thing. Spectacles can not take photos. At first, this seems odd but Snap has learned from Google’s missteps. Snap may be limiting the ability to take photos to thwart the privacy concerns. The light allows someone to know when someone is recording but a photo would be harder to convey to others.

AirPods have only one gesture, a double tap, which you may set to contact Siri or play/pause. I miss not being able to adjust the volume with my headphones. This constraint has affected my behavior. After years of slow adoption, AirPods has increased my Siri usage.

Coolness

Both products have that X factor of coolness. Not very scientific but the products look and feel cool. People are curious about both and strangers will stop you to ask questions. In Venice the stops are more of an attack of how could I support Snap, who is “ruining” Venice. Spectacles, being smack dab on your face, get more questions than the AirPods. People express concern but are less freaked out about being recorded than I expected.

The Spectacles’ storefront on Venice is the epitome of cool. Facebook or Twitter isn’t pulling something off like this and wouldn’t think it’s worth it. Facebook once caught criticism for no longer being cool, as if that signaled doom. Companies don’t have to be cool to be successful but coolness can be a differentiator. Right now, Snap owns cool in the Mobile Entertainment space.

Bottom Line

Spectacles and AirPods are simple, cool and useful. I will use AirPods nearly every day making their $159 price tag cheap considering the value. Spectacles won’t get that amount of use, I prefer the aesthetics and feel of my New Wayfarer Ray Bans. Now that I live in Sunny LA, I’m sure I’ll wear them over 100 times this year. At $129, they’re worth it….as long as you don’t lose em!